Policy Creation and Implementation in a Time of Economic Decline - Essay Example

?Introduction There are many reasons explaining the root causes of the 2008-2009 Economic Crisis. They could be broken down into two positions that characterize the United States economic and social systems. On the social side there was the desire of people to own their own homes. On the economic side there was the desire of financial interests to make profit. US policy promoted both of these sides. It is difficult to place total blame for the resulting economic crisis on either side. Furthermore it is difficult to blame U.S. policy if one were to sanction and promote the positives of the free market system upon which it is based. But if one accepted the principles of free market economics then it would have to be said the problems, from the economic side, are systemic, they are built into the system. From the social side, the desire of people to own their own home would initially appear to be based on ability to afford a house and not on government policy. If the government were to adopt a policy encouraging home ownership, then it would seem that individuals would change habits to acquire and save capital to take advantage of government policy. Over the years, government policy has been directed toward encouraging people to acquire and own homes. This report will show, however that another policy which the government pursued made home ownership a difficult and complicated affair that wound up doing not what it was suppose to do, but creating an economic crisis. Discussion McClendon explains how federal policy led to legislation that created the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) in response to the Great Depression (McClendon, 2010). The two organizations sought to provide a secure way in which people who wanted to be homeowners could take out loans that were eventually secured by the Fannie Mae and Freddic Mac. Operating as private arms of the government, these two organizations protected bank loans provided to future home owners, encouraging the saving and normal use of capital over the term of the loan. Fannie Mae and Freddie Mac only insured government sponsored mortgages written and secured by the Federal Housing Administration or the Department of Veteran Affairs. The firms operated in the banking secondary market and packaged loans into securities which they sold in domestic and international financial markets for insurance. Over the years, as the country emerged through the Depression and several wars, reaching the modern period, many people were unable to economically qualify for conventional loans. There were also usury laws in effect, on the state level, that prevented banks from charging high interest rates. McClendon explains how during the early 1970s Fannie Mae and Freddie Mac entered the conventional loan market, buying loans from banks and savings and loans associations (McClendon, 2010). McClendon points out how during the 1980s, federal policy changed the laws placing limits on banks (McClendon, 2010). In 1980 Congress passed the Depository Institutions Deregulation and Monetary Control Act. This Act freed banks from state usury ceilings, enabling them to charge conventional high interest rates to appropriate populations for home mortgage loans. This meant that a tradeoff could be made for those who had bad or no credit, they could get mortgage terms by paying higher interest rates. This act also raised the deposit insurance limit up to $100,000. It had been $40,000. More money was then available from the pool of loans. Another act passed by Congress was the Alternative Mortgage Transaction Parity Act of 1982. This Act allowed banks to make adjustable rate and interest-only mortgages outside of state restrictions. All of these laws sought to enable a wider pool of people to enter the home ownership market. But they also served to deregulate the financial industry. In 1982, Congress under President Reagan passed The Garn-St. Germain Depository Institutions Act of 1982. This Act enabled savings and loans banks to enter the lending market with low loan-to-value ratios (McClendon, 2010). The Act freed these institutions from having a large amount of capital on hand to back up the loans which they made. The result was a wild and uncontrolled period of speculation in which financiers began to make huge profits from the suddenly expanding market of people seeking loans. From this policy initiated by the federal government that liberated banking rules, the expanded market of debtors began to default. The savings and loans industry, overburdened with debt, soon collapsed from the unregulated speculation of the financiers. As a result thousands of Americans lost their life savings, and thousands of savings and loans executives went to jail. Charles Keating was one of those speculators who went to jail. He was a major example of the executive who changed his accounting books to hide defaulting assets while continuing to speculate while cashing in on huge profit. His lawyer was Alan Greenspan. After Keating was prosecuted, President Ronald Reagan appointed his lawyer, Alan Greenspan, as chairman of the Federal Reserve Bank. Greenspan had argued that his client had 'a sound business plan' and that there had been 'no foreseeable risk' (Dillon and Cannon, 2010). The Glass-Steagall Act had been passed in 1933 in response to what the Congress and President had determined as "improper banking activity" that led banks to supply funds for speculators in the stock market crash that caused the Great Depression. The Act was designed to protect bank depositors money by disallowing banks to engage in investment activities. In 1999, under President George Clinton, Congress passed the Gramm-Leach-Bliley Act which overturned Glass-Steagall. Banks were allowed to merge their activities with investment companies begin investments insured with consumer deposits (McClendon, 2010). This Act resulted in several merges that produced huge banking investing institutions. Citicorp merged with Travelers Group in 1998 to create Citigroup as the largest financial services institution in the world. Gramm-Leach-Bliley Act was passed in 1999, in effect legalizing the merger that had already taken place. Certainly federal policy was toward a relaxation of the rules governing banks. Not only did the banks become larger, but the executive salaries of the bankers became astronomical. Robert Rubin, vice chair of the new Citigroup conglomerate and later President Clinton's Secretary of the Treasury, made $126 million in his eight years as CEO of Citigroup. The growing might of the investment banks gave them power to manipulate the new technology market of the later 1990s into a massive bubble that crashed the stock market in 2001. Five trillion were lost in deposits. Ten major investment banks, including Merrill Lynch, Lehman Brothers, and Bear Stearns, were eventually fined 1.4 billion dollars for their duplicity. Certainly corporate social responsibility for banks was at its state of nadir, influenced and protected by federal government policy (Schechter, 2010). By the end of the 1990s, the new banking instrument, the derivative, merged with computer technology. Investment bankers used the derivatives to make innovative forays into the financial markets that sought to expand risk. President Clinton's economic advisors, Greenspan, then President of the Federal Reserve Bank, and Larry Summers, President Clinton's second Secretary of the Treasury, refused to allow the Commodity Future Trading Commission to regulate the derivatives market. Senator Phil Gramm sponsored a bill, which passed Congress and was signed into law that banded regulation of the derivatives market. Investment banks created the collateralized debt obligation (CDO) as a security financial instrument built on grouping of underlying assets. These underlying assets could be mortgage loans that are bunched together to spread risk. CDOs soon evolved into credit default swaps (CDSs), which were securities of insurance, bought for protection if the CDOs failed. CDOs and CDSs remained unregulated. It was the unregulated flow of CDOs and CDSs that directly caused the recent global economic crisis. For example, editors bought CDOs from AIG, the largest financial insurance company at the time, to speculate against something which they eventually didn't own. All the major investment banks were involved in purchasing CDOs and backing them up with CDSs. They included Merrill Lynch, Bear Stearns, J.P. Morgan, Citigroup and Lehman Brothers. The executives began to collect huge salaries and stock benefits. Furthermore, federal policy fell directly under the control of the Wall Street executives. They became members of the President's cabinet and close advisory circle. Alan Greenspan, Larry Summers, and Robert Rubin demonstrate how the titans of financial industry, the CEOs and attorneys of the big investment banks themselves become the federal government policy makers. In 2004, Henry Paulson, as CEO of Goldman Sachs urged the SEC under the Bush administration to relax limits on leverage allowed banks, so that they may increase borrowing during the rising housing market and make more profit. Paulson's wish for more leverage was granted. In 2006, President Bush appointed Paulson Treasury Secretary. By 2008, the large investment banks, starting with Bear Stearns, and then Lehman brothers and Merrill Lynch, facing declining stock market prices and a housing market of defaulting payments, were unable to meet their capital requirements and busted. All three banks went belly up insolvent with unheard of loan to bank deposits ratios of 28:1, 31:1, and 33:1 (Lewis, 2010). Federal policy at the top was deregulation of the financial industry. It represented a repeat of the policy that occurred during the early 1980s and led to the savings and loan crisis with thousands of people losing their savings and homes. In 2008, who were these people? Norton writes of the group of people who cannot qualify for the loans normally provided for mortgages, or prime loans which are based on conventional, published rates - the process goes on today (Norton, 2005). These people are in the subprime category and must face a battery of loans that have higher interest rates because they have a higher risk of not repaying the loan. They are usually characterized as having poor credit or no credit record. Furthermore, usually they are located in the poorest areas and "disproportionately come from minority groups (Norton, 2005). They have become foil to what is commonly called the predatory loan industry. This is the industry that is expected to charge high interests on loans made to people who cannot get conventional loans. Conventional banks have left their neighborhoods. The role these banks would have played was taken over by the predatory lenders. In the early 2000s, the predatory lenders were big mortgage companies such as Countrywide and xxxx. They used various loan packages, such as the adjusted rate mortgage, to bring in the risky pool of mortgage buyers. The loans were then bunched together and sold on the secondary market as collaterized debt obligations backed by credit default swaps. Risk then was spread throughout the market and the original loan terms were buried and hidden. A gigantic Ponzi Scheme took over the American housing market. Promoted by federal policy of deregulation, millions of the common people lost their houses to foreclosures. Resolution Led by Treasury Secretary Henry Paulson and Federal Reserve Bank Chairman Ben Bernarke, and New York Federal Reserve Bank Chair Tim Geithner, the federal government immediately pursued both fiscal and monetary policy to pump money into the fail economy and to lower federal bank interest rates. Under President Bush the Troubled Assts Relief Program (TARP) was passed on October 3 2008 as a $700 billion stimulus program to inject funds into major Wall Street banks to buy their failed assets. The Federal Reserve System undertook monetary policy and had dropped interest rates to zero and began printing $1 trillion in money to offset Wall Street failures (Thecapital.net, p. 4). The Obama Administration continued to Bush administration's combined policies with the The American Recovery and Reinvestment Act of 2009 (ARRA, Pub.L. 111-5). Under ARRA a total of $1 trillion was injected into the economy (Zander, 2010). The TARP funds proved to be economically beneficial, rescuing the auto market and placing a temporary floor in the housing market. Major banks paid back the TARP funds enabling the government to realize a profit. Yet ARRA was delayed in slow but deliberate distribution of funds to the states. Some states even refused funds on political grounds but were forced by their constituents to cooperate. Zander explains that the success of the ARRA was due to the fact that a big change, the expenditure of $400 billion injection into the economy, occurred all in the second quarter of 2009. Critics have maintained the economy did not show the improvements, such as in job creation, that the Obama administration had forecasted. However, more somber accounts of the stimulus explained that the depth of the recession setback of the economy had not been fully appreciated. The Center on Budget and Policy Priorities argued that the ARRA prevented a record number of Americans from falling into poverty (Shermon, 2011). Using figures from the Census Bureau, the CBPP demonstrated that 4.5 million Americans were kept out of poverty. In 2008 the poverty rate was 15.8 and in 2009 it 15.7. Specific measures of the ARRA which did this were extensions of unemployment benefits, renewal of the Child Tax Credit and Earned Income Tax Credit, extensions of the food stamp program (SNAP), the Making Work Pay tax credit, and a one-time payment to the elderly. The ARRP proved an effective and successful policy measure in alleviating poverty compared only to the Social Security Act of 1935 (Shermon, 2011). Conclusion What were the reasons explaining the root causes of the 2008-2009 Economic Crisis? There were many. But in the end the root cause points to an unregulated banking and financial market. This report has presented a series of laws demonstrating how banks were deregulated since the 1980s. There were, in many cases, good reasons for the deregulation which this report did not review. These reasons had to do with the freeing up of capital and making it possible for financial institutions to fairly compete. But markets change with the global macroeconomic setting. Government policy must be flexible and, as much as possible, forever sensitive to its citizens and their housing needs. Works Cited Capitol.Net. 2009. Economic policy crisis and the stimulus. TheCapitol.net. Accessed at http://books.google.com/books?id=lYne_qbjo6kC&printsec=frontcover&dq=Economic+policy+crisis+and+the+stimulus&hl=en&ei=NFVxTfvuDIHqgAevz8VA&sa=X&oi=book_result&ct=result&resnum=1&ved=0CDQQ6AEwAA#v=onepage&q&f=false Dillon, Patrick and Cannon, C.M. 2010. Circle of Greed: The spectacular rise and fall of America's most feared and loathed lawyer. New York: Random House. Lewis, M. 2010. The big short: Inside the doomsday machine. New York: Norton. McClendon, J.K. 2010. The perfect storm: How mortgage-backed securities, federal deregulation, and corporate greed provide a wake-up call for reforming executive compensation. University of Pennsylvania Journal of Business Law, 12: 131-179. Norton, A.B. 2005. Reaching the glass usury ceiling: Why state ceilings and federal preemption force low-income bnorrowers into subprime mortgage loans. University of Baltimore Law Review. 35:1-36. Schechter, D. 2010. The crime of our time: Why Wall Street is not too big to jail. New York: The Disinformation Company, Ltd. Shermon, Arloc. 2011. Despite deep recession and high unemployment, government efforts - including the recovery act - prevented poverty from rising in 2009, new Census data show. Center on Budget and Policy Priorities. (CBPP) Accessed at http://www.cbpp.org/files/1-5-11pov.pdf Zandi, Mark, and Blinder, Alan S. 2010. How the Great Recession was brought to an end. Moody's Analytics. http://www.economy.com/mark-zandi/documents/End-of-Great-Recession.pdf Read More